The question I’m frequently asked is “Do I really need to consider a retirement plan for my business?” The answer is typically “Yes”. The question arises, generally, because the owner of the business or professional practice does not want to add unnecessary overhead or increase costly unnecessary and unappreciated benefits. And, the thought is, incorrectly, that all those employed will have to participate.
Why consider a “retirement” plan?
Because these plans are not about retirement! For the business or professional practice owner these plans are about the income tax deduction, the tax deferred growth, and the asset protection features under ERISA (the Employee Retirement Income Security Act of 1974).
These plans are frequently called “qualified plans” because the contribution ‘qualifies’ for an income tax deduction
For the 2014 year, considering a 401k plan, you may have as much as $52,000 contributed to your account. Age 50 and older, the maximum annual contribution can be $57,500! Let’s assume that you are age 52. In 2014 you may defer $17,500 from your salary plus an additional $5,500 “catch up” contribution, for a total salary deferral of $23,000. Add to that the employer contribution and you can achieve a total “annual addition” to your account of $57,500! The entire contribution is income tax deductible! Have a spouse on the payroll? Children? They may each have a deferral so the tax benefits only get better.
What if the $57,500 is not significant enough of a deduction? Consider a Defined Benefit (DB) Plan. A DB plan can generate, in some instances, annual tax deductible contributions of up to $250,000. Combine the Defined Benefit with the 401(k) plan and you can create a strong vehicle for tax savings!
Are there other benefits?
Consider that these plans are trusts, specifically tax exempt trusts, under Internal Revenue Code Section 401. That means all the capital gains, interest, dividends, etc., are escaping current income tax. These monies escape taxation until they are withdrawn from the plan. The inevitable tax levy may be delayed until age 70 ½ when one must begin taking RMD’s, or Required Minimum Distributions. It is not as bad as it may sound. At 70 ½ the RMD is just under 4%. If you are earning 5% or more on the invested dollars you continue to maintain an appreciating asset!
ERISA specifically says these plans are “inalienable and non-assignable”. What does that mean? Inalienable means you cannot be alienated from your pension account. In other words, judgment creditors cannot take your pension monies! If someone wins a civil suit against you, like malpractice or a ‘slip and fall’, the monies in the ERISA plan are not “up for grabs”! These plans are especially favored by those in high risk professions and those vulnerable to creditor claims. Who can get pension monies? A spouse in a divorce. But then, they are not “judgment creditors”. Generally speaking, in a divorce spouses split their retirement accounts with each other unless agreed otherwise.
As mentioned earlier, the contributions to these plans are income tax deductible. With so many private businesses and professional practices established as “pass-through” entities such as S-Corporations, Sole Proprietorships, or LLP and LLC’s electing to be taxed as an S-Corp or Sole Proprietorship, these plans have the effect of reducing the taxable income on your personal Form 1040. So what? Since the plan reduces your taxable income, you may now reduce quarterly estimated tax payments! Or, if one has unresolved tax levies, the amount one has to pay monthly toward the outstanding unpaid tax balance is a function of one’s monthly income. If one’s income is reduced as a result of the pension contribution the amount paid toward the tax bill is reduced too.
Life insurance is another feature available in these plans. Why consider life insurance in a pension plan? The tax benefits offered! Any life insurance you own personally is paid for with after-tax non-deductible dollars. For every $1,000 you pay in premiums you have to earn almost $1,700, to pay the income tax on that income, to have the $1,000 left to pay the premium! Consider that, by owning the life insurance in the pension plan, you are now deducting the premium. Every $1,000 you pay in premium is paid for with deductible dollars. So the $1,000 being deductible creates a 40% tax savings, your net cost is $600 owning the life insurance inside the plan rather than the $1,700 owing it outside the plan! That’s not all. When the insured passes away the survivor’s benefit is income tax free to the beneficiary (to the extent it exceeds the policy’s cash value), estate tax free to the spousal beneficiary, and outside of probate!
Don’t Put it Off
Why not start the tax savings program now? Many unfounded reasons abound.
- “I have to include all my employees and it will cost too much!” This is generally an unfounded concern. Obtain a projection of costs. You may be pleasantly surprised by how it works out.
- “I will pay the tax now or pay it later, what’s the difference?” Believe it or not, it can be proven mathematically that deferring the monies provides substantially more future value than the alternative.
- “These plans are too expensive to maintain.” Compare the fees to the tax benefits. The tax benefits greatly outweigh the fees.
There is no time like the present to consider these plans and the benefits. With the new tax rates your deductions are even more attractive! Consider the time value of money. The more you set aside, the longer you set it aside, and the more it grows, the more you have! It’s that simple. Add to that the asset protection features and other outlined benefits; you’ll wonder why this was not done earlier. Don’t put it off; obtain a projection for your particular situation. Get your CPA or other qualified and competent advisors involved in the decision making process. You may be surprised by the benefits and features and wish you had done this earlier!
Tax Benefits of a Qualified Plan
Tax Benefits of a Qualified Plan
2014 Tax Rates
Qualified Plan Contribution
Net Taxable Income
Federal Tax Levy (43.4%)†
State Income Tax
(assumed at 6%)
†Federal Tax assumes maximum rate of 39.6% + 3.8% new Medicare tax
*Net After Tax includes the pension contribution + remaining revenue after tax levy.
About the author: William H. Black, Jr. has been in the pension administration business for 34 years. The firm Pension Services, Inc. administers both defined contribution and defined benefit plans, employs an ERISA attorney, an Enrolled Actuary, and complete clerical staff. Bill is qualified to give continuing education to CPA’s in 47 different states. He has spoken nationally and internationally on retirement plans, has been quoted in USA Today, written articles for several industry journals and has appeared on many financial radio shows discussing the topic of retirement and financial matters. He is a much sought after speaker and author.